Debt Ceiling: What US Government Default Would Mean For You

Imagine Junk Rating for U.S. Debt

"The key issue there is would the administration be able to prioritize so that when the interest on the outstanding debt came due, they would have the resources to be able to make those payments?" Foster said. "That's why the markets for the most part have not really worried too much about the near-term effects of this because they are pretty confident that Geithner would in fact make all the interest payments on the debt. The markets aren't really in any doubt that the interest will be paid and the full faith and credit of the U.S. government will be protected, so all of this talk about Armageddon --- from a Wall Street perspective -- is laughable. It's pure political rhetoric ...

"But something very dramatic would happen on Aug. 2 and that is federal spending would be cut by some 40 percent and nobody really knows how the government is going to then prioritize spending past the interest expenses," he cautioned.

The idea outlined by Foster, known as prioritization, has been met by opposition from Geithner and Federal Reserve chairman Ben Bernanke, among others. Geithner denounced it as "unworkable," while Bernanke warned that it could "create serious concerns about the safety of Treasury securities."

In addition, discretionary spending includes such vital components as the nation's air traffic control system and rent subsidies, so picking and choosing which expenditures would be cut and which would continue would be no small feat.

Jerome Powell, who worked at Treasury under President George H. W. Bush, said in a report for the Bipartisan Policy Center that contrary to suggestions from people such as Foster that prioritization is possible, "The reality would be chaotic: unfair results, unanswered questions; Treasury picking winners and losers; public uproar; [and] intense global media focus."

If the government were unable to manage its payments despite no more incoming cash, it would default. Then major credit rating agencies would downgrade the U.S. debt, forcing Treasury bondholders to sell their holdings because many investors have requirements that their holdings be highly rated. For instance, one official at Standard & Poor's said, the agency would downgrade the United States from the top rating of AAA down to D; a junk rating.

Then, once the default is resolved, the government would see an immediate increase in the interest rates it has to pay in order to borrow money, the same way a family that misses some of its mortgage payments would also see an interest-rate increase.
JP Morgan and PIMCO have both said a default would result in a 0.5 percent increase, something that could mean an extra $10 billion a year in interest rate payments and $75 billion a year over time as the country refinances its short-term debt.

In turn, that would mean higher interest rates for consumers because the rates that consumers pay for mortgage, auto, student and credit loans are tied to what the federal government pays. Such a sequence of events would send the stock market into a tailspin, the likes of which could make the crash in the fall of 2008 seem minor. JP Morgan estimated that the market could drop by close to 9 percent in the three months after a default.